Bernstein Drops STMicro To Sell: 2H Disappointment Likely

By Teresa Rivas

STMicroelectronics (STM) is falling more than 2% on Tuesday following a downgrade from Bernstein Research.

Analyst Pierre Ferragu and team cut their rating on the stock to Underperform, writing that they have been concerned about the turnaround at its digital convergence group (DCG) revenues from its microelectromechanical sensors (MEMS) but that the company’s disappointing revenue and third-quarter sales guidance last week has made them turn more bearish.

Given this, they expect the company to disappoint through the second half of the year, with growth in these segments falling short of what’s needed to meet consensus estimates. They also believe management will have to cancel or postpone its goal of 10% margins.

Autos, Industrials and Microcontrollers have been exceptionally strong in the first half, supported by car unit growth in North America and China, the macroeconomic recovery (to some extent dampened by a slow smartphone market), and 32-bit design wins. Next year, we expect Autos to grow slower, against a tougher compare and with growth shifting to regions with lower semi content per car, Power to accelerate as the smartphone market recovers, and Microcontrollers to slow, as 32-bit competition increases. Overall, we model the 3 segments, representing ~70% of revenues, to grow 7.5% next year.

In MEMS ST Micro hasn’t grown since 2011. The industry is much more competitive today than it was when STM established its leading position in Motion MEMS. As an illustration, Bosch won a key socket for the iPhone, at the expense of STM. This, combined to a slowdown in high-end smartphones should continue to weigh on STM’s revenue growth and margins. In order to compensate for this trend, STM is expanding into other type of MEMS (OIS, Pressure, Microphone), but without a leading position, we doubt the company can make up for share and profits lost in Motion MEMS. Lastly, STM is attempting to gain share in non-mobile segments, which will at best take time, given usually longer design cycles (e.g. auto). We model STM growing in line with the broader MEMS market at ~5% p.a., a forecast on which we see potential downside risk.

In DCG, the decline in set top box revenues is structural, playing out for at least 3 years, driven by STM’s position on low ASP and highly competitive segments.. Although we understand a design win in the US is set to support revenues in 2015, we remain cautious. Moreover, the company’s stated ambition to double DCG revenues by the end of next year relies a lot on the success of FD-SOI, which is a material risk factor as the technology still has to prove it can deploy a sustainable ecosystem. We model growth significantly below management ambitions, which we believe are unrealistic (18% in 2015 vs. 45% implied by management). A back-of-the-envelope analysis suggests management ambition to double DCG revenues corresponds to 10pt gain in set-top box market share in NA and EMEA and doubling of ASIC revenues. This is in our view far too ambitious.

Overall, we expect STM to miss consensus in the second half and next year, and even more so its operating margin ambition. 3Q guidance supports our modelling of a mild recovery in DCG and continued weak growth in MEMS. We are now ~30% and ~16% below consensus for the second half and 2015, modelling slightly higher gross margins but higher opex.

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